There are a variety of structures used in Australia by developers for the ownership and operation of hotels. One of the most common models for new developments is a ‘hotel management agreement’. 

Developers will generally select a hotel manager with the assistance of an experienced consultant, after a thorough and competitive process to identify a manager that provides the brand offering, track record and cultural fit that the developer is looking for. Indeed, the relationship of trust and transparency developed during the selection process is a core element in a successful long term relationship. However, these preliminary discussions understandably do not delve into the more complex mechanics and risk allocations that will be set out in the hotel management agreement. The first time some of these issues are canvassed is during the negotiation of long form documents. 

In this article we consider some of the elements of hotel management agreements that are especially relevant for developers – whether they intend to own the asset for the long term, or sell the asset once the hotel business is established and has a financial track record to support an enhanced sale price. 

Quick links: 

• The benefits of hotel management agreements 
• The interface between the hotel and residents to the manager 
• Risks during the construction phase 
• Changes to brand standards 
• Extended tenure and rights to terminate 
• Direct and indirect fees 
• Balancing controls and deployment of the operator's expertise 
• Exit routes 

The benefits of hotel agreements 

Under a hotel management agreement, the developer appoints an experienced hotel manager (and often the owner of the relevant brand) to operate the business on the developer’s behalf. The relationship has a variety of benefits for both the developer and the hotel manager:

• The developer can procure a hotel brand that aligns with the overall positioning of its development, and assist in the sale of apartments (including both from the perspective of the prestige of any brand, and the possibility of procuring access by apartment owners to hotel facilities, such as pools).
   
• The developer secures an experienced operator to manage its business, with access to an established and proven brand and systems.
   
• The developer retains control over the business and entitlement to all profits (calculated after fees are paid to the manager and relevant retentions accounted for).
   
• The manager, where it owns the relevant brand, extends its footprint, to the benefit of all properties that operate under that brand or within the relevant brand stable, and does so without investing the capital and time required to develop a new property.
   
• The manager avoids the risks associated with owning a hotel, and secures an ongoing revenue stream, which in turn enhances the value of its business and hedges risk associated with more volatile or prospective ventures. 

The relationship is purely contractual - the owner retains ownership of the site, owns all fixtures and fittings, receives all revenue and is liable for all losses of the hotel business. The manager’s role is to operate the business on behalf of the developer under the terms of the hotel management agreement. Understanding this dichotomy is critical – the majority of legal and business risk resides with the developer, with the hotel management agreement comprising the central tool in reallocating responsibilities (where appropriate). 

The interface between the hotel and residents to the manager

Where the hotel forms part of a larger residential development, a number of specific issues need to be addressed in the hotel management agreement, owners corporation rules and ancillary documents. The relevance of these issues is increasing, as more wholistic offerings within premium developments become routine (with residents being promised or expecting access to hotel facilities and services). For example:

• If it has been represented to residents that they will receive access to hotel facilities or services, how will those access rights be secured?
   
• How will residents share the operation and maintenance costs associated with hotel facilities or services they access (e.g. will it be on a user pays basis, will residents individually subscribe to access facilities, or will this be subsidised via the relevant owners corporation)?
   
• To the extent the hotel operator will need access to parts of the development that comprise common property of the residents, how will the landowner secure those rights? 

All these issues need to be worked through between the developer and manager and consideration given to how they may change over time.

Risks during the construction phase 

There are various risks and opportunities which present themselves during the construction phase of a hotel project, which we have set out in our previous article: Construction of hotel projects: opportunities and risks. This phase of the project will be regulated by a ‘technical services agreement’, which is generally executed prior to the hotel management agreement. Developers need to take care when negotiating the terms of this document, as acceptance of certain positions can have implications for the hotel management agreement.

Changes to brand standards 

The developer’s capital investment in the project, and constructing a hotel that complies with the manager’s brand standard and technical specifications, will obviously be significant. The hotel management agreement will often include generalised provisions around the manager’s right to change those standards and the developer’s obligations to upgrade or change the hotel to comply with the new requirements. The parties should discuss and understand how quickly those standards may change during or after construction of the hotel – as any developer will want to guard against the possibility of making further capital expenditure soon after the property’s opening.

Extended tenure and rights to terminate 

Hotel management agreements will generally grant an extended term to the manager, with limited rights for a developer to terminate the agreement for financial performance of the hotel (with the relevant test being measured over multiple years, and the manager usually having a right to financially ‘top up’ the developer to protect against termination). Given the very low likelihood of a right arising for the developer to terminate the hotel management agreement for underwhelming financial performance, the developer’s oversight of the budget and spending, and visibility over early warning signs of a downturn in performance, are important. 

Direct and indirect fees 

The manager will generally be paid fees based on a percentage of revenue and an incentive fee based on the hotel’s profitability (in an attempt to align the interests of both parties to increase both revenue and profitability). However, the manager will also receive fees for other goods and services involved in the operation of the hotel. In some instances such goods and services simply replace fees that would other be paid to a third party by the developer, but developers ought to drill down and understand exactly where related party arrangements will be in place and what approval rights it will have over such engagements. These may include the following:

• White label / related party goods and services used in restaurants, spas, bathrooms and other hotel facilities? What criteria must such goods and services meet and will they be market tested?
   
• What reservations and other software systems will be supplied by related parties of the manager and what are the costs associated?
   
• Will the developer be required to pay a percentage of hotel revenue to a ‘brand fund’ operated by the manager, and does the developer understand how these fees are generally applied and in what regions?

Balancing controls and deployment of the operator's expertise 

As with any service based contract, a balance needs to be struck between:

• the developer providing the manager with sufficient approvals so that it can efficiently operate the hotel on a day to day basis (the manager having been chosen for its expertise and experience); and
• the need for the developer, which has full financial exposure for the hotel’s performance, to have general oversight and control over expenditure. 

Accordingly, aspects of the hotel management agreement that need to be carefully worked through include the following: